Sustainability integration in Quantitative Equity strategies

10-03-2015 | Insight

Robeco is committed to sustainable investing. All Robeco Quantitative Equity strategies already integrated ESG factors (Environment, Social and Governance), and since December 2014, we have taken this one step further.

It goes both ways

A key feature of our new approach is that companies with a favorable ESG score have a higher chance of ending up in the portfolios as we ensure that the portfolio’s ESG score is at least as strong as that of the benchmark or reference index. This implies that we also positively screen stocks, contrary to an exclusion policy which only allows for negative screening.

Increasing sustainability while maintaining exposure to the model factors

Whereas a holding in one or two mediocre companies would not be a reason for immediate alarm, a strong exposure to unsustainable companies at the portfolio level poses a serious risk, as certain sustainability risks could materialize in the future. We expect our policy to be beneficial in such cases. Empirical analyses show that the improved sustainability profile can be achieved while maintaining the same attractive exposure to the quantitative model factors. Stocks with corporate governance issues or major litigation or regulatory risk may be excluded from the investable universe.

Sustainability measured by RobecoSAM scores

To measure sustainability, we build on the experience of RobecoSAM. Every year since 1999, RobecoSAM obtains financially material information from a range of public sources and directly from companies by inviting them to the annual Corporate Sustainability Assessment (CSA) survey. RobecoSAM has one of the largest proprietary corporate sustainability databases with over 3,000 companies. Dedicated sustainability researchers integrate the latest sustainability insights into the survey and analyze the information obtained.

Rapid increase in emerging markets coverage

RobecoSAM follows a best-in-class approach. Companies receive a RobecoSAM score between 0 (low) and 100 (high) on environmental, social and corporate governance factors and are ranked against other companies in their industry. The growing attention for sustainability is reflected by year-on-year increases in the company participation rate. Especially in emerging markets, RobecoSAM’s coverage has increased significantly, with around 75% of the companies in the MSCI Emerging Markets index being covered. In terms of market capitalization this is more than 90% of the index. This allows for a consistent integration of sustainability in all quantitative products. The sustainability scores are further enhanced in-house to be most effective for our quantitative strategies.

“We ensure that the portfolio has a weighted sustainability score that is at least as high as that of the relevant index”

ESG integration in the investment strategies

We made an enhancement to the investment processes of all quantitative equity strategies in December 2014. In our Global Enhanced Indexing strategies we have already been integrating ESG factors since 2010, as the stock selection model used for this strategy contains a sustainability factor. For our other strategies we used an exclusion policy by not overweighting or including stocks of companies that score very poorly on the RobecoSAM sustainability score in each sector. With our new policy we integrate ESG factors in all the quantitative equity strategies.

Portfolio sustainability score at least as high as that of the index

In the portfolio construction phase we ensure that the portfolio has a weighted sustainability score that is at least as high as that of the relevant benchmark or reference index. This implies that companies with a favorable sustainability score have a higher chance of ending up in the portfolios, especially during moments when needed, namely when the portfolio score is on the low side.

“The improved sustainability profile does not change the exposure to the quantitative model factors”

Unchanged risk-return characteristics

In these simulations, we find that the exposure to the quantitative models hardly changes when the new policy is implemented. A measure to quantify this is the average weight of the portfolio in the 20% most attractive stocks, which e.g. for our Global Conservative Equities strategy is more than 70%. We observe that this number stays similar or decreases by 0.2% at most in our strategies. The reason this figure hardly changes is that for each attractive stock that does not score well on the sustainability factor, there are sufficient sustainable alternatives.

Empirical analyses

The figure presents simulated historical empirical analyses for four of our core strategies that we use as an example: Global Enhanced Indexing, Global Conservative, Emerging Markets Core Quant and Emerging Markets Active Quant. Our sample starts in September 2001 for developed markets, when the RobecoSAM scores became available, and in September 2008 for emerging markets, when there was sufficient coverage. It ends in December 2013. We show the weighted enhanced sustainability scores of the simulated portfolio and benchmark through time, where a higher score means more exposure towards companies with a higher sustainability score.

Indeed we observe that the portfolio’s score is mostly higher and sometimes equal to that of the index for all strategies. For strategies with a larger active share, such as Conservative Equities, we can expect larger differences in terms of sustainability score. This is also visible from the graph.

Source: Robeco. Figures present results of historical simulations based on the current strategies. Sustainability scores are ranked on a scale from 0% (lowest) to 100% (highest).

A form of avoiding unrewarded risks

We consider the integration of sustainability factors a form of prudent risk management. With our enhanced form of ESG integration we avoid the risk of being overexposed to less sustainable companies, and our empirical results show that this is associated with unchanged risk/return characteristics. This is in line with our general risk management philosophy to avoid all risks which are not rewarded with higher returns.

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